Treasury yields continue slide with traders wary of 'curve inversion'

Ellis Copeland |Friday, December 07, 2018

A trader works on the floor at the New York Stock Exchange in New York City US Dec. 4

Global equities have been shaken by fears of a recession, fanned by the flattening U.S. Treasury yield curve - a phenomenon in which longer-dated debt yields fall faster than their shorter-dated counterparts. Meanwhile, the U.S. Federal Reserve Chairman Jerome Powell had commented during last Wednesday that U.S. interest rates were nearing neutral levels. If the trend in the graph below continues, there could be a two-year/10-year yield curve inversion by the end of 2018.

Simply, the yield curve tends to invert before economic downturns. The Dow Jones Industrial Average closed down almost 800 points, or 3.10 percent, and the Standard & Poor's 500 fell over 90 points, or 3.24 percent.

Gundlach said the Fed will need to be especially careful in its choice of words when they meet this month to deliver on their promised rate hike.

The dollar, which started the week on a weak footing as the apparent thaw in trade tensions between the US and China cooled demand for the safe-haven currency, extended its fall as investors anxious about the inversion of the short end of the USA yield curve in bond markets.

Here's what that does: Yields on short-term bonds rise above those of longer-term bonds, historically a signal that an economic slowdown is around the corner.

In fact, one section of the yield curve has already inverted: between 3-year and 5-year notes. "We are following a strategy and taking account of data over time as it comes in and in response to significant changes in direction".

The closely watched spread between two-year and 10-year bonds dipped below 0.1 percentage point on Tuesday, the lowest since before the last recession and continuing a slide that began in October.

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MSCI's gauge of stocks across the globe shed 2.16 percent, its worst performance since October 11.

Italian bonds extended their rally, with two-year yields falling 10 bps to 4 1/2-month lows after a cabinet official raised hopes that the government could cut almost four billion euros from its 2019 budget plans. The yield curve has flattened as continuing interest rate hikes send short-dated yields higher, while longer-dated Treasuries are supported by tepid inflation and slowing global growth.

The outlook for US growth, by contrast, he said remained strong. In recent weeks expectations about what the Fed will do next year have eroded, with investors now anticipating policymakers will raise rates only one time next year, and, coupled with an expected increase in December, pause with a federal funds rate of around 2.7 percent.

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